Wednesday, October 9, 2013

Toying with the monetary transmission mechanism


Does it matter what the Fed buys? ...from whom? ...or how? I don't think so.

The Fed currently buys and sells government-issued and guaranteed securities from designated primary dealers. It does so publicly and transparently. In the case of QE, it announces ahead of time the quantities it will purchase. Prior to 2008, it announced that it would conduct enough purchases to drive the fed funds rate up or down by x%.*

But let's modify the monetary policy transmission mechanism a bit. Say that a few years from now the Fed decides to buy and sell bitcoin, bitcoin claims, and other cryptocoins instead of government securities. Rather than executing these trades through a select posse of firms, it'll transact broadly with Joe Public. And rather than announcing purchasing intentions, it will carry them out surreptitiously. Big as these changes may seem, altering the route won't impede the transmission of monetary policy. Whether it quietly buys bitcoin from the public or pre-announces government bond purchases with primary dealers, the Fed will still continue to keep a firm grip on the economy's price level.

There are a few ways for a hypothetical bitcoin transmission mechanism to work. Here's one way. Say the Fed wants to loosen policy and push prices up by, oh, 5%. Fed officials fan out across the US, looking for local bitcoin over-the-counter exchanges. Bitcoin OTC markets exist on street corners, in coffee shops, houses, cafés, public libraries, city parks, and bars. These informal OTC exchanges are where Joe Public congregates to truck and barter bitcoin. Once located, the Fed officials begins to write out cheques to OTC traders in exchange for bitcoin at the going market price. The Fed now has bitcoin on the asset side of its balance sheet. OTC traders have Fed cheques which they proceed to deposit at their local bank.**

So far the Fed's purchases haven't had an effect on the price level — neither the price of bitcoin nor the price of goods have budged. Note that even if Fed officials accidentally nudge bitcoin OTC prices up a bit through their buying, arbitrageurs will quickly counterbalance this by routing sales away from centralized bitcoin exchanges like Mt-Gox (assuming it still exists in a few years) to OTC markets, driving OTC prices back to their fundamental value.

The OTC traders' Fed cheques having been deposited in the banking system, banks proceed to load them into Brinks trucks for delivery to the local district Fed for clearing and settlement. During the clearing process, a large settlement imbalance in favor of private banks emerges, an imbalance that has arisen thanks to the Fed's cheque-writing campaign. The Fed settles its debts by crediting the reserve accounts of creditor banks with newly created deposits.

Only now is our bitcoin transmission mechanism poised to push prices higher. Banks collectively find themselves with an excess stock of reserves. But there is no place for this excess to go. Within the next few hours, banks will madly compete to get rid of their reserves. They'll do so by buying up financial assets like bonds, stocks, MBS, and bitcoin from other banks.*** As a result of their combined efforts, the prices of all these assets will quickly rise. Put differently, the purchasing power of reserves will fall. This decline will only stop when the purchasing power of reserves has fallen to a low enough level that they are once again willingly held by bankers. While this will happen very fast with financial asset prices, stickier prices like goods and labour will take longer to adjust upwards.

In a nutshell, that's how the Fed's bitcoin purchasing policy succeeds in increasing the price level. And if the Fed falls short of hitting its 5% growth target, it need only send out more officials to write more checks for more bitcoin until it hits its mark.

Let's make a few changes to our transmission mechanism. To streamline the process, the Fed decides to funnel purchases to a select number of bitcoin dealers rather than spraying them broadly. Should the Fed require it of them, these chosen dealers are required to quote the quantity of bitcoin they are willing to sell and at what price.

Does the decision to funnel purchases rather than spray them change anything? Not at all. Fed cheques are still deposited by bitcoin sellers at their banks and these checks are settled with reserves. Whether funneling or spraying, banks still end up with an excess reserve position which they will try to rectify by simultaneously buying up assets. The only resolution to this will be a quick rise in prices. A primary bitcoin dealer system, it would seem, is no different a transmission mechanism than our earlier broad Joe Public approach.

The Fed may even require that bitcoin dealers hold inventories of government bonds and submit bond quotes from time to time in addition to bitcoin quotes. Even if the Fed decides to purchase bonds rather than bitcoin, nothing about the transmission mechanism changes—Fed cheques still result in excess reserve positions at banks, and these can only be equalized by a rise in prices. But now we're back at our current system in which primary dealers sell bonds to the Fed.

The Fed may even start to publicly announce its intentions to make bitcoin purchases rather than surreptitiously writing checks. Anticipating that they will soon be inundated with excess reserves upon hearing the announcement, banks won't wait for the reserves to arrive before trying to offload them. Rather, they'll sell immediately. This will quickly push asset prices higher. Smart speculators and investors, anticipating that forward-looking bankers will quickly spend their reserves after the Fed announces its intention to buy bitcoin, will try to beat the bankers to the punch by purchasing assets the moment an announcement is made.

So when the Fed's purchasing intentions are announced, market prices adjust even before the Fed carries out the actual purchases. Without an announcement, however, the cheques must physically enter the economy and cause a reserve imbalance before prices begin to adjust, a process that will only start a day or two after and will proceed in a jagged manner.

The upshot of all this is that it doesn't matter what the Fed buys, nor from whom. Monetary policy works irrespective of the route. As for the "how",  the Fed's decision to publicize their intention to make bitcoin purchases rather than quietly writing out cheques has the effect of dramatically speeding up what would otherwise be a circuitous transmission process.



* For simplicity, I'll be assuming a world in which the Fed doesn't pay interest on reserves.
** Even if OTC traders don't accept cheques, they'll accept bank notes, and the same analysis applies.
*** In addition to purchasing financial assets, banks will try to lend them away to other banks in the interbank market, receiving the overnight interest rate in return. This will cause the interbank lending rate to fall. 

35 comments:

  1. I'm a little confused, are you essentially saying that the open market operations of the Fed produce no Cantillon effects, so that where money enters the economy doesn't matter for relative prices?

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    1. That's probably one way of putting it. But I don't want to reignite the Great Cantillon Effects debate. There will always be re-distributional effects thanks to expansionary monetary policy. However, it isn't the early recipients who necessarily benefit but those who own flex-price assets.

      By the way John, are you the John Hawkins who wrote this paper?

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    2. Sadly not, my work's in finance, econ is just an intellectual hobby

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  2. Yep. When you pour some more water into a bucket, you know the level in the bucket will rise. Whether the new water all ends up at the top, or at the bottom, or somewhere in between, doesn't matter. It could go anywhere.

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  3. "But there is no place for this excess to go. Within the next few hours, banks will madly compete to get rid of their reserves. They'll do so by buying up financial assets like bonds, stocks, MBS, and bitcoin from other banks.*** As a result of their combined efforts, the prices of all these assets will quickly rise."

    Holders of assets will make gains as asset markets rise as a result of portfolio rebalancing. This class of people gains for doing nothing. People such as the unemployed, students, people that only have maybe a car or few assets will not benefit or benefit less. People with little or no assets may benefit if employment or wages rise which means they have to work to gain something. Wages to GDP are always declining and the value of assets is much greater than the value of GDP so this effect is very skewed anyway.

    To balance everything out just directly credit every citizen an equal amount of newly created money when conducting policy. Everyone experiences the wealth effect and rebalances their portfolio.

    In the example you provided I didn't even factor the efficiency of market pricing mechanisms, transaction costs and any form of market collusion if it exists which distorts transmision mechanisms.

    Also when a bank rebalances into loans it creates money so banks have a greater effect on prices than non banks which cant create things like deposits when they rebalance.

    Plus directly interacting with the public will instill more confidence and education in the general public which is vital for the functioning of the institutions.

    "altering the route won't impede the transmission of monetary policy."

    I think the route is essential. If I take long way to the shop it should be more costly than taking the shorter way.

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    1. Directly lending to every citizen is similar to buying bitcoin off of them, or stocks, or bonds. The moment the plan is announced, banks will quickly sell off their reserves. After all, they anticipate a large future inflow of reserve balances as citizens deposit cheques and make payments. Financial asset prices will quickly rise to a new equilibrium level, even before the cheques have been cashed. But sticky priced goods, wages, and services will be slow to react. No matter what the route taken, owners of flex price goods like financial assets enjoy a relative gain, at least until wages and goods prices catch up.

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    2. Of course everyone will rebalance, the effect will be different though if peoples accounts are increased with newly created money. The fed doesnt need to buy anything it can just monitor inflation or NGDP and if it is too low then it just expands money to reach its target.

      If people broadly expect to or do receive an increase in money an increase of goods and services will be realized more than an increase in demand for financial assets when compared to banks. People use money differently to banks, banks don't spend as much proportionally on goods and services. Spending on goods and services directly affects demand more than movements in financial assets becuase large swaths of the populace dont hold financial assets and many rich peoples spending habits wont even be affected if their financial wealth increases anyway. Therefore wages and employment will increase more if goods and services demand increases when compared to an increase in demand for financial assets.

      The effect on the credit channel is different also. People will pay off debt more and their balance sheets will improve making them more credit worthy. People become more credit worthy if they have more employment. Many people are unemployed and their credit worthiness will improve if they gain employment but wont improve if asset prices increase because they don't have assets.


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    3. My bitcoin spraying example is the same as directly increasing people's accounts. The only difference is that the Fed is buying personal IOUs with checks, not bitcoin.

      Whether the Fed writes cheques to primary dealers for bonds, writes cheques to households for bitcoin, or writes cheques to households for personal IOUs, asset prices will universally be the first to adjust because they aren't sticky. The process by which sticky priced goods & services catch up is the same for each route.

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    4. It isnt the same for the reason I explained in my previous post. The fed is taking bonds off the market and reducing the return on money which is pushing up the attractiveness of risk assets. So far the transmision is fine. Here is where the problem starts though. Once asset prices increase it doesnt transmit significantly into greater demand or address the credit channel.

      Asset price increases wont increase demand from the many people that have little or no assets (unemployed, students, youth, etc...) and the people that have alot of assets dont increase demand much either. Therefore prices of goods and services wont increase much. The credit channel wont start up again becuase balance sheets of all the people without assets or little assets dont improve so they dont become eligible for credit.

      On the other hand if people broadly directly get money they have a much higher propensity to consume than asset holders. This picks up AD and goods prices, employment and accesibility to credit becuase they become employed after AD picks up. You dont see banks rebalance their portfolios into 10000 haircuts or movie visits do you? People that are barely getting by dont rebalance their portfolios out of cash into risk assets they are barely getting by they might just spend it on food or gas.

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    5. "Once asset prices increase it doesnt transmit significantly into greater demand"

      Where in my post did I say that rising asset prices cause greater demand for goods and services? You may want to double-check that you've properly digested my post.

      "Therefore prices of goods and services wont increase much."

      So conventional monetary policy can't drive up CPI? That's a controversial statement to make.

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    6. ""Once asset prices increase it doesnt transmit significantly into greater demand"

      Where in my post did I say that rising asset prices cause greater demand for goods and services? You may want to double-check that you've properly digested my post."

      This premise of your article is that the route of the transmision mechanism is not important. In my comment I am detailing how altering the route affects the economy differently.

      "Big as these changes may seem, altering the route won't impede the transmission of monetary policy. Whether it quietly buys bitcoin from the public or pre-announces government bond purchases with primary dealers, the Fed will still continue to keep a firm grip on the economy's price level."

      "So conventional monetary policy can't drive up CPI? That's a controversial statement to make. "

      I didnt say that. I said if aggregate demand doesnt pick up significantly neither will prices.

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    7. I provide not just a premise, but a structure in which too work things out. That's why I've created the bitcoin transmission mechanism with Joe Public and primary dealers. You've simply read my premise and skipped the structure. If you want to continue the conversation, please do so using the structure I've created -- there are reasons I spend so much time setting up these examples.

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    8. "My bitcoin spraying example is the same as directly increasing people's accounts."

      You made the above comment. I directly referred to both structures in my comments. The structure of directly increasing in peoples accounts and also the primary dealers and also detailed the different effect on the economy. You haven't rebutted my observation of the differences between both approaches.

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    9. Rereading your comments, I see now that you're talking about helicopter drops. This is basically fiscal policy, or a tax cut. My post is about pure monetary policy. As my first line says... does it matter what the Fed buys? from whom? Helicopter drops don't involve the purchasing of anything, they are giveaways. I tried to reconfigure your scheme as a purchase of an IOU but that's probably not what you're interested in.

      However, when we're talking about purchases, not helicopter drops, do you agree that it makes no difference if the Fed buys bitcoin from public OTC markets or primary dealers?

      In any case, I do appreciated your comments as they make me think more carefully about my positions.

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    10. JP, in your reply to lxdr you wrote:

      So conventional monetary policy can't drive up CPI? That's a controversial statement to make.

      But as you also noted in your hot potato post,

      As a central bank issues ever larger amounts of reserves... their marginal convenience yield, falls towards zero. As this happens, the hot potato effect becomes almost negligible—each subsequent issue of reserves increases the supply of what has already become a free good.

      So doesn't lxdr have a point? Isn't that more or less where the Fed finds itself right now?

      I'm confused about exactly how the scramble to get rid of excess reserves and bidding up of financial assets leads to increased prices for goods and labor (in normal, non-ZLB times). Is it the wealth effect (holders of flex-price assets feel richer and spend more, starting a HPE)? Or is it that banks increase lending on the margin to projects that are now attractive due to the decreased convenience yield on reserves? (Or both?)

      I thought the HPE doesn't apply to financial assets, so in times like now, when banks are flush with reserves (and new reserves provide negligible con. yield), how do increased financial asset prices lead to higher prices for tangibles like goods and labor?

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    11. Re: helicopter drops--couldn't these be construed somewhat like the Fed overpaying for assets, Sproulian-fashion? ("Buying" nothing from households, or essentially trucks of rotten carrots). Legality aside, wouldn't it have the same effect?

      In your Archimedes post, you listed four ways to push up NGDP at 0% int rates:

      1. Miles Kimball's floating conversion rate and negative returns
      2. Sproulian purchases at wrong prices****
      3. Krugman's New Keynesian credible commitment to keep future interest rates too low
      4. Market monetarist's credible commitment to keep future non pecuniary returns too low

      #1 would be confusing (floating conversion), and Kimball's proposal to eliminate cash would also be a very hard sell to the US public (though I believe it has been nearly achieved in Sweden[?}). #3-4 require commitment by the future Fed, which the market can't be certain of. So aren't helicopter drops (#2, buying nothing) the best way forward?

      The public already has experience getting checks from the government (the Bush "stimulus" checks, although these were tax rebates). They surely wouldn't object to another round, if the Fed could legalize helidrops. (Re: the mechanics--wouldn't Fed helichecks be processed just like checks to BTC owners?)

      Helidrops would relax the "survival/liquidity constraint" on households, allowing them to make nominally fixed payments on things like rent and mortgages. It would also increase their real cash balances, since prices for goods and services will take time to adjust, thus leading them to spend unwanted excess cash. Good result, right?

      Beckworth also endorsed helidrops, as I'm sure you've read.

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    12. IMO the common definition of monetary policy is slightly incorrect. If the monetary authority is altering the money supply in order to achieve its policy goals I would regard that as MP. Just becuase the CB is dealing with the public (when the mechanism is put in place without depending on the gov) I dont think stops it from being MP.

      I would say the current MP approach isn't really pure MP as it involves asset purchasing. "Pure" IMO would be just affecting the money supply on its own without buying assets.

      I see four main initial effects in bitcoin traders and dealers example :

      1) the bitcoin OTC traders or dealers rebalancing out of deposits (fed checks)
      2) the banks receiving these checks will result in an equal amount of new liabs in form of deposits from OTC traders and an equal amount of new reserves
      3) the banks rebalancing out of excess reserves above their RR
      4) Bitcoin supply taken off market and held on fed balance sheet will drive up its price.

      The effects seem to be quite similar in both examples if we assume the rebalancing of OTC traders and banks will be the same. But I dont think everyone has the same investment and consumption habits or needs. For example small OTC traders will reallocate portfolios different to bigger dealers IMO. But I'm getting a bit too deep on this.

      In reality I rekon the fed would prefer to invest in a 51% attack on the bitcoin network rather than buying bitcoin. But your example is a good mental exercise.

      The transmision mechanism does matter. It matters who you interact with becuase everyone invests or consumes differently. It also matter if the CB is buying assets which I dont see as necesary if they monitor prices and bring money into effect in a balanced and measured manner.

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    13. John, by conventional monetary policy I mean pre-2008 Fed policy and/or current policy at many central banks like the BoC, RBNZ, RBA etc. In a conventional environment, the zero-lower bound is not viewed as a problem and supply of settlement balances has been kept artificially tight. My post is written in this context. We know that monetary policy worked perfectly in a conventional environment. If lxdr/Mike is right that purchases through primary dealers can't cause prices or aggregate demand to rise (ie. "therefore prices of goods and services wont increase much" or read his comments at Sumner's blog claiming that the Fed doesn't control inflation) he needs to explain the success of conventional policy (which is also Sumner's criticism here).

      The hot-potato effect doesn't apply to financial assets... as long as those assets don't provide a marginal consumption return, or convenience yield. You're right that the marginal overnight convenience yield on reserves is currently at zero, however the distant convenience yield (1-5 year) is probably still positive. So the Fed can still create a hot potato effect by attacking the distant convenience yield. Once that yield has hit 0 across the entire curve, we really have hit the end of the hot potato road.

      As for helicopter drops, this post is more about the theory behind purchases at market rates, not giveaways or overpayments. Yes, you could view drops as buying rotten carrots, or "Sproulian purchases". I agree that they would be useful in a liquidity trap type situation. All 4 of the options on that list have their weaknesses and strengths -- I'm still feeling my way towards which one I prefer.

      I would add one other simple "hack" to that list. Don't ban cash, just issue $1s, $5s, and maybe $10s. Call in all $20s, $50s, and $100s. Low denomination notes are bulky and expensive to store. That way come the next crisis, the Fed can safely drop rates to -2% or -3% without fearing mass cash withdrawal. Regular people will still be able to use low-denomination cash and enjoy the benefits of privacy. Criminals, probably the main users of high-denomination notes, will be out of luck. Such a small modification would be unlikely to face legal hassles. [link]

      "I'm confused about exactly how the scramble to get rid of excess reserves and bidding up of financial assets leads to increased prices for goods and labor (in normal, non-ZLB times)."

      I'll try and write a post on this at some point.

      Good comments, by the way.

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    14. MP didnt work perfectly in normal times. Weve had many crises influenced or directly caused by MP. I do agree that it did have a degree of success though. It's a medicore or less effective MP mechanism than what we could have, which alot of the time gets a pass grade but it doesnt excel and certainly is not perfect. But MP could be much more efficient.

      " If lxdr/Mike is right that purchases through primary dealers can't cause prices or aggregate demand to rise"

      I didn't say prices cant rise. I said the effect of the current mechanism is limited or weak on aggregate demand or prices. The effectiveness of the mechanism varies mainly according to how widely held the assets that move are and the credit channel.

      I think the fed doesnt control inflation. I think it influences it. It doesnt dictate to price setters where they should price things. The degree of influence may vary.

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    15. JP, I've asked Sumner a few times about helicopter drops, and his stock responses are:

      1) Japan tried helidrops, and they didn't increase NGDP.
      2) Drops are wasteful and would increase the nat'l debt.

      #1 doesn't really seem like a great criticism b/c he's largely equating gov't spending to helidrops (although apparently the BoJ did directly print some money for pensions). Also, he says the problem in Japan was that the BoJ maintained a credible commitment to fight inflation, so the public held onto excess cash instead of spending it. But this doesn't seem like a point against drops per se--if the central bank maintained its resolve, it seems like drops would reliably create inflation/NGDP growth.

      http://www.themoneyillusion.com/?p=22990

      #2 is somewhat confusing for me, although I was able to find a few interesting discussions from a while back on other blogs.

      http://www.interfluidity.com/v2/918.html
      http://www.interfluidity.com/v2/4388.html
      http://neweconomicperspectives.org/2010/01/helicopter-drops-are-fiscal-operations.html

      One point I would like to see emphasized more is made by Nick Rowe: helicopter drops should be seen as a mixture of both fiscal and monetary policy, not just pure fiscal policy (as certain MMT/Post-Keynesians are wont to call it).

      http://neweconomicperspectives.org/2010/01/helicopter-drops-are-fiscal-operations.html#comment-659

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  4. Hi JP. I'm trying to square BE (bitcoin easing) with your previous posts on GE (google easing) and the HPE at the ZLB. I think you are saying BE is different than GE because bitcoin is unbacked (actually that would be a good future post, since I think stock is not purely "backed"... shares of lululemon are not the same as shares of a water utility; conversely, bitcoin is "backed" by its own network [requirement for online drug system])? Also, if reserve prices suddenly hit 0% there would be no price effect; is there something unique about BE vs QE? (Wouldn't the SNB buying of Euros be similar? No inflation there.) Cheers.

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    1. If the Fed writes $-denominated cheques to buy bitcoin, or if in an alternate monetary universe Google writes G-denominated cheques to buy bitcoin, it's the same thing.

      As long as Fed $'s and Google G's are useful in transactions and in scarce supply, then a hot potato effect will occur should $ or G be added or removed (via bond purchases/sales, or bitcoin purchases/sales, or X purchases/sales). However, at the zero-lower bound, neither $ easing nor G easing will be particularly effective.

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  5. Nice post JP, but...
    You are simply describing the usual transmission mechanism.
    I think the debate is more something like: what happens if this transmission mechanism doesn't work? Banks could well decide to hold more excess reserves (precautionary reserves in case of a crisis, as we've seen over the last few years).

    The Fed could have a direct impact on prices if it deployed thousands (if not millions) of its employees throughout the country to directly buy plenty of goods and assets. But it's not in its current capabilities. (unless it injected cash by directly crediting everybody's current account?)

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    1. Ok, let's talk about a malfunctioning transmission mechanism. When times are bad and expected to stay that way for a long time, Fed injections of reserves will simply be held by banks since they can perpetually earn 0% on reserves rather than investing at, say, -1%. However, this applies just as equally to your deployment example. Even if Fed employees fan out across the US and directly buy assets from households, why would people spend the cash they receive if they can hold it and enjoy a 0% return rather than investing it at -1%? In each cases, the Fed has troubles pushing prices higher.

      In short, if the transmission mechanism is blocked, changing the route doesn't unblock it. If the transmission mechanism is unblocked, changing the route doesn't block it.

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  6. Is there any way to calculate the effect of additional QE assuming that it is only done in exchange of assets at fair value? Lets say total amount of reserves is 100 x, the Fed does QE with 10 x, what would this do to the value of reserves? It would lower the liquidity premium by 10% perhaps? How do we know how much the liquidity premium on reserves is?

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    1. We can get a rough idea of the liquidity premium by looking at the fed funds curve. As long as there is some point along the curve that is positive, then a liquidity premium exists. A positive rate, after all, indicates that the market is requiring compensation to part with reserves over that time frame --- if reserves weren't valued for their liquidity, the market would require no compensation.

      I don't think there is a mechanical relationship between amount of reserves and their liquidity premium. Here is one attempt to compute it:

      http://www.bankofcanada.ca/wp-content/uploads/2012/05/wp2012-15.pdf

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  7. "if the Fed falls short of hitting its 5% growth target, it need only send out more officials to write more checks for more bitcoin until it hits its mark."

    If you had said that the Fed issues 5% more reserves, (or currency) and gives them away, then I'd agree that the price level would rise 5%. But if the fed issues 5% more reserves (or currency) while getting 5% more assets, the price level would not change. You said the same thing about Google stock a few posts back.

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    1. Mike, I agree that giving away reserves would also do the trick. And that normally, an exchange of asset x for asset y at market prices would not cause the price of asset x to fall.

      I'm assuming in this post that reserves also provide a marginal non-pecuniary return and this causes them to trade at a price above their backing value. Any increase in reserves reduces their marginal non-pecuniary return, driving their value down towards their backing value. So that's how an increase in reserves allows the Fed to hit its inflation target.

      However, when too many reserves have been created their non-pecuniary return will be worth nothing on the margin. At this point, if the Fed issues 5% more reserves while getting 5% more assets, the price level will not change.

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    2. That assumes that those reserves have no way to reflux to the issuer, but that is tantamount to a removal of backing. So either way, it is only by a loss of backing that we get inflation.

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    3. There's also the problem that if you think that the moneyness premium is 4%, then reserve-creation can drive the value of money down by 4% at most.

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    4. "That assumes that those reserves have no way to reflux to the issuer, but that is tantamount to a removal of backing."

      Mike, good points as always. If reflux/efflux occurs via free conversion into x oz gold, then no premium will ever develop since there are no limits to supply. If reflux/efflux is conditional or limited in some way, then an issuer can restrict the amount of circulating media to ensure that a premium develops. It's ability to do so derives from its monopoly power. So we can get some inflation without losing backing. (However, you might say that the central bank's monopoly franchise is the backing that creates the premium -- the more it issues more its monopoly shrinks, as does its backing, as does the premium.)

      In your second comment, that's an interesting point. I agree that there doesn't seem to me much latitude for monetary policy if all it does is shrink or increase what is a very small premium.

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    5. I've been thinking about that monopoly/moneyness premium a lot lately. It seems like if the monopolist central bank is restricting money issuance enough for a premium to develop, it would also be restricting it enough for a recession to develop.

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  8. You make a lot of interesting and thought provoking posts, JP. I need to think about this one.

    One thing is puzzling me though. If the FED wants to inflate the dollar, this makes it more likely that people switch to Bitcoin as both a medium of exchange and store of value. And companies like E-Gov Link allow you to pay your taxes with Bitcoin. Who would there be left to hold the dollars if this continues? In the end, the only one would be banks (due to reserve requirements, the ability for the payment processors to pay taxes with dollars, and things like that) and the government. But banks would have no customers because the dollars would only be bought at the time when the tax is due, and only to be immediately transferred to the government. There would also be no reason to hold any of the bonds or other instruments issued by the treasury denominated in dollars, because the interest on them might not be sufficient to outweigh the appreciation of bitcoins.

    Also, the mechanism you describe requires an accessible trade mechanism between bitcoins and dollars. But this prevents the government from executing capital controls when people do not want to hold dollars anymore. And what if it turns out the other way around, that the government regulates bitcoin exchanges out of the legal field? Will the FED execute monetary policy in back alleys, meeting with bitcoin dealers?

    What I'm trying to point out that various governmental institutions might have goals that run counter to the goals of the FED. That would be paradoxical if the government itself were the greatest obstacle for achieving goals of monetary policy.

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  9. Late in the party...

    FED buying bitcoins cannot bid them over the fundamental value but HPE between banks will do the trick with the assets in general and push the prices higher, why?

    I would say banks has pretty good information on the quantity and one gets the almost perfect collusion scenario; the only effect is then that the yield of the reserves will go down?

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